Why U.S. Equities Merit Selective Optimism

Why U.S. Equities Merit Selective Optimism

Companies with positive earnings revisions, strong free cash flow and exposure to secular growth themes continue to attract capital, while those lacking operational leverage or pricing power are being left behind.

The U.S. equity market stands at a pivotal juncture as we approach the new year—buoyed by a resilient economy, evolving policy dynamics and transformative innovation, yet tempered by valuation concerns and geopolitical uncertainty. While the macroeconomic backdrop suggests a year of moderated returns, pockets of opportunity may well open up—driven by deregulation, a resurgence in capital expenditure and the next wave of Artificial Intelligence (AI) adoption. Our overall sentiment is constructively bullish, but we also think investors should be selective across sectors and styles.

On the macro level, U.S. equities can be expected to enter 2026 with growth momentum. The U.S. economy continues to defy recessionary expectations. Consumer spending remains resilient, labour markets are tight but gradually cooling, and inflation is showing signs of normalization. The U.S. Federal Reserve’s pivot toward a more balanced stance—potentially cutting rates in the second half of 2026—adds a layer of support for risk assets and credit-sensitive sectors.

Yet the most significant tailwinds may come on the policy front. With the potential return of a pro-growth administration, markets are increasingly pricing in a wave of deregulation across energy, financials, defence and healthcare. This shift could help unlock a new cycle of corporate investment, margin expansion and productivity gains.

A key policy catalyst is the so-called One Big Beautiful Bill Act, which allows companies to fully expense qualifying capital expenditures. This provision is already reshaping corporate behaviour. According to banking advisory firm Evercore, it could drive a US$162-billion boost to S&P 500 Index free cash flow in 2025, rising to $190 billion in 2026. These funds are expected to be reinvested into infrastructure, automation and digital transformation—marking a critical inflection point in U.S. corporate capital expenditure.

Importantly, this reinvestment is not just cyclical—it’s strategic. Recent global events have underscored the importance of domestic manufacturing capacity in critical industries such as semiconductors, pharmaceuticals and defence technology. Supply chain vulnerabilities exposed during the pandemic and rising geopolitical tensions have accelerated the push toward reshoring and national industrial resilience. We expect targeted investment in semiconductor fabrication facilities, biotech facilities and advanced manufacturing hubs to be a defining theme of the next cycle.

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The implications for sectors like industrials, semiconductors and select financials are profound. Companies that enable or directly benefit from this capital deployment—whether through infrastructure buildout, automation technologies or financing solutions—are likely to see outsized performance in the year ahead.

Will these trends support broadly higher market valuations in 2026? We are now entering Year 4 of the bull market that began in late 2022. Historically, this phase is marked by moderated returns and greater dispersion of returns across sectors and styles. It’s a period where broad market momentum gives way to more selective leadership, and fundamentals begin to matter more than macro narratives.

Year 3, which we’ve just concluded, was defined by a powerful rebound in earnings, a normalization of inflation and a surge in enthusiasm around transformative technologies, particularly artificial intelligence. The market rewarded growth and innovation, especially in mega-cap tech, which drove much of the index-level performance. However, it also revealed the early signs of fatigue in crowded trades and stretched valuations.

As we transition into Year 4, the S&P 500 Index continues to trade at elevated multiples, especially among the largest technology names. Yet valuations are not uniformly excessive. Beneath the surface, there is a growing bifurcation: companies with positive earnings revisions, strong free cash flow and exposure to secular growth themes continue to attract capital, while those lacking operational leverage or pricing power are being left behind.

In this evolving landscape, we see four key themes emerging. 

Generative AI: still early in the cycle

The AI narrative is evolving rapidly. While foundational models and cloud infrastructure have dominated headlines, the next wave—agentic AI and physical AI—is emerging. This includes autonomous vehicles, robotics and AI-driven industrial automation. Our view is that we are still in the early innings of the AI trade. Current capital expenditures tied to AI remain modest compared to past tech cycles, and the compute ecosystem—while gaining weight in the S&P 500 Index—is far from saturated.
We believe this places us closer to 1996 than 1999 in the AI cycle. In 1996, the Internet was gaining traction, infrastructure was being built, and early leaders were emerging. By 1999, speculative excess had taken over. Today, AI adoption is real but still ramping, with enterprise use cases and monetization just beginning to scale. This supports a constructive stance on AI-related equities, especially those with real revenue growth, scalable platforms and exposure to infrastructure and compute layers.

  Defence and cybersecurity: underpriced growth

Defence spending is set to surge, with North Atlantic Treaty Organization (NATO) targeting 3% of GDP by 2029. U.S. defence exports are poised for double-digit growth, yet many defence stocks are not pricing in this upside. We see opportunities in aerospace, cybersecurity and AI-enabled platforms. Defence companies are well-positioned to benefit from streamlined procurement and increased global demand.

Industrials: capital expenditure revival

Industrials are at the core of the capex revival—automation, reshoring and infrastructure upgrades are driving demand across machinery, logistics and engineering services. With U.S. corporates expected to significantly increase capital expenditures, select names in construction, rail and industrial software offer compelling risk-reward profiles. This sector also stands to benefit from deregulation and fiscal support.
A critical, yet often overlooked, aspect of this infrastructure surge is the need to modernize the U.S. power grid. Much of America’s electrical infrastructure is now over 25 years old and strained by rising demand—driven not only by electrified transportation, but also by the growth of AI data centres, renewable energy and renewed nuclear power. 

  Healthcare: innovation vs. regulation

Healthcare presents a mixed picture. On one hand, deregulation could reduce compliance costs and accelerate innovation. On the other, pricing pressures and political scrutiny remain headwinds. We prefer life sciences tools, biotech platforms and digital health over traditional providers. Companies that can demonstrate clinical differentiation and cost-effectiveness are likely to outperform in a more value-conscious environment.

Despite the constructive outlook for U.S. equities, several risks warrant caution. Among them, geopolitical tensions, particularly in the Middle East and Asia, could disrupt supply chains and energy markets. As well, policy uncertainty could arise around U.S. midterm elections next year and potential shifts in fiscal priorities, and fatigue may set in among American consumers—still the biggest drivers of the U.S. economy—as excess savings dwindle and student loan repayments resume. Finally, there is no getting around the fact that some sectors, especially mega-cap technology, are over-owned, which raises the risk of valuation compression.

2026 is shaping up to be a year when macro meets micro. The combination of policy tailwinds, capex acceleration and evolving innovation themes creates a fertile ground for equity investors. But the landscape is not without risks. In our view, active management will be critical in navigating the dispersion of returns and identifying winners. Whether it’s defence, industrials, or the next wave of AI, the opportunity set is rich—but capitalizing on it requires discipline, agility and a clear investment framework.